DEBRE MARKOS UNIVERITY

COLLEGE OF BUSINUSS AND ECONOMICS

DEPARTMENT OF ECONOMICS

Determinants of Economic Growth in Ethiopia (1984-2013)

Prepared by:

NAMEI D NO
1. Enyew Abebaw 3664/07
2. Getnet Ledamo 3679/07
3. Mekonen Minalu 3700/07
4. Fiseha Tesema 3669/07
5. Dero Girma 3658/07
Advisor: Melesse F. (MSc)

A senior essay paper submitted to the Department of Economics in partial fulfillment of the
requirements of Bachelor of Arts degree in Economics

May, 2017.

Debre Markos, Ethiopia.

ACKNOLEDGEMENT

First and for the most we would like to forward our thanks to almighty God and his mother (St.
merry) who always help us throughout our life. We are so glad that God has given our health
and patience to accomplish this BA degree senior essay paper. It is fact that without mercy of
God we could not have been done anything and this paper would not have finalized in its present
structure.
Secondly, we would like express our deepest gratitude to our adviser Mr. Melesse F. for his
insightful comment and suggestion from the beginning up to the end of our paper work. We
really highly appreciated for his detailed, constructive and timely comment.

Furthermore, it is hardly possible to forsake the contribution of our family in general for their
unreserved support throughout our stay in Debre Markos University and also we would like to
forward our deepest and special thanks to our lovely fathers.
ABSTRACT
Our paper has investigated the major determinants of economic growth in Ethiopia for the period
of 1984-2013 time series data. It employs OLS approach to identify the major determinant. This
study is conducted based on secondary data and the methodology uses unit root test.
According to findings of this paper The empirical results reveal that gross capital formation,
export of goods and service and inflation have positive statistically significant impact on
economic growth in Ethiopia during the study period .while debt affects economic growth
negatively and statically insignificant in this period.
Hence, policy makers and or the government should strive to increase capital formation
(investment) which is believed as a back bone of growth and has allocate adequate finance on
productive areas In addition to this effort, the government there should be subsidized export
oriented sectors to broad export base and a close monitoring and consistent debt management
strategies, which is used to avoid misallocation and mismanagement of external debt problem. In
addition to this the government should kept a reasonable inflation rate to stimulate economic
growth through the use of fiscal and monetary policies.

KEY WORDS ;

RGDP =total amount of goods and services produced in a given nation at one year.

GCF = the sum all physical capital investment and saving in a country .

EXD =the amount of currency that a given nation borrowing from abrad,

INF = the average nominal price of goods and services in a year .

List of Tables page

Table 4.1 Determinants of economic growth in Ethiopia regression result ……………..

Table 4.2. Augmented Dickey fuller unit root result table…………………………………

Table 4.3 multicollinearity test …………………………………………………………………

table 5.1-DATAS USED IN REGRESION…………………………………………………….

..
List of figures

Figure 4.1 trend of gross capital formation in Ethiopia …………………………………….

Figure4.2Trend of total export on Ethiopian economy ………………………………………..
Figure 4.3 .trend of external debit on economic growth……………………………………….
Figure 4.4 .Trend of inflation in Ethiopia economic growth…………………………………..
ACRONYEMS
ADF Augmented Dickey Fuller
AFDB African Development Bank
ARDL Autoregressive Distributed Lag
CSA Central Statistical Agency
ECM Error Correction Method
EEA Ethiopian Economic Association
EPRDF Ethiopian People Revolutionary Democratic Front
GCF Gross Capital Formation
GDP Gross Domestic Product
GTP Growth and Transformation Plan
HDI Human Development Index
HIPC Highly Indebted Poor Countries
IMF International Monetary Fund
MDGs Millennium Development Goal
MoFED Ministry of Finance and Economic Development xi
NBE National Bank of Ethiopia
OECD Organization for Economic Co-operation and Development
OLS Ordinary Least Square
PASDEP Plan for Accelerated and Sustained Development Plan to End Poverty
PMAC Provision Military Administration Council
R&D Research and Development
RGDP Real Gross Domestic Product
SDPRP Sustainable Development and Poverty Reduction Program
SSA Sub-Sahara Countries
UEC Unrestricted Error Correction
UN United Nations
UNDP United Nation Development Program
WBI World Bank Index
Table of content

Content Page

Acknowledgment………………………………………….…...............................

Abstract…………………………………………………………………………………………..

List of tables …………………………………………………………………………………

List of figures…………………………………………………………………………………

CHAPTER ONE: INTRODUCTION………………

1.1. Background of the study………………………………………..

1.2. Statement of the Problem…………………………………….

1.3. Objectives of the Study…………………………………………

1.4. Research Questions…………………………………………………
1.5. Significance of the Study……………………………………………..
1. 6. Scope of the Study……………………………………………………..
1.7 .Limitations of the study……………………………………………

CHAPTER TWO: LITERATURE REVIEW………………

2.1. Theoretical literature reviews ……………………………………..
2.1.1 The neo-classical theory of Growth………………………………
2.1.2The Endogenous theory of Growth…………………………………..
2.2 Empirical Literature Review…………………………………………..
2.3.Macroeconomic Performance of Ethiopian economic growth………………..
2.4 Conceptual frame work…………………………………………………………….

CHAPTER THREE: METHODOLOGY OF THE STUDY

3.1 Type of data and source………………………………………………

3.2Variable description………………………………………………..

3.3. Methods of data analysis………………………………………………….

3.4. Model specification………………………………………………………..

3.5. Estimation test……………………………………………………………….

CHAPTER FOUR: RESULT AND DISCUSSION

4.1. THEORETICAL ANALYSIS…………………………………………………..

4.2. Empirical results discussion………………………………………………………………..

CHAPTER FIVE: CONCLUSION AND RECOMANDATION

5.1. Conclusion…………………………………………………………………………….

5.2. Recommendation…………………………………………………………..

Reference……………………………………………………………..
CHAPTER ONE: INTRODUCTION
1.1. Background of the study

The sources of economic growth is a question of great importance concern for many economists
who are interested to know and search for factors enabling some countries to grow and develop
while others are suffering from abject poverty. Economic growth is an issue of primary concern
to policy makers in both developed and developing countries. As a consequence, growth theory
has long occupied a central role in economics. It is a dynamic process, focusing on how and why
output, capital, consumption and population change over time. The process of economic growth
and the sources of differences in economic performance across nations are some of the most
interesting, important and challenging areas in modern social science. The sources of economic
growth is a question of great importance to many economists who are interested to know and
search for factors enabling some countries to grow and develop while others are suffering from
abject poverty(IMF,2007)

Growth is usually calculated in real terms: that is inflation-adjusted terms to eliminate the
distorting effect of inflation on the price of goods produced. Measurement of economic growth
uses national income accounting. Economic growth or economic growth theory typically refers
to growth of potential output. As an area of study, economic growth is generally distinguished
from development economics. The former is primarily the study of how countries can advance
their economies. The latter is the study of the economic aspects of the development process in
Economic growth is defined as the increase in the market value of the goods and services
produced by an economy over time. It is conventionally measured as the percent rate of increase
in real Gross Domestic Product (IMF, 2012).

Low-income countries the trend of growth of real GDP can be considered as sustainable
economic growth while the short-run fluctuations of growth over the trend can be thought of as
business cycles. Economic development on the other hand includes economic growth,
distribution of income; levels of literacy and education standards, levels of health care, quality
and availability of housing, levels of environmental standards, unemployment and poverty (Seid,
2000).
The Economic growth of Ethiopia has various changes in different political regimes .These
changes in government structure created a problem of inconsistency in implementing the policies
by previous regimes as well as natural disaster like famine, drought, political instability and war
had a depressing effect on the history of Ethiopian economic growth (Alemayehu and Befekadu,
2005).

Because Ethiopia is one of the poorest countries in the world, its economy remains heavily
dependent on agriculture, which accounts 43% (UNDP, 2014) of the GDP. Accordingly, 83% of
the population gains its livelihood directly or indirectly from agricultural production. Despite the
fact that the history of growth performance was poor in the past decades, the country has
experienced strong economic growth in the current time. Real GDP growth averaged 11.2% per
annum during 2003/04 and 2008/09 period, placing Ethiopia among the top performing
economies in sub-Sahara Africa (NBE, 2013/14).

The Ethiopian economy has experienced impressive growth performance over the last decade
with average GDP growth rate of 11 %, which is about double of the average growth for Sub
Saharan Africa. 2012/13 was markedly successful in terms of maintaining macroeconomic
stability and fiscal management as witnessed by inflation falling to a single digit, which had been
a major challenge in the past two years. To achieve the vision of millennium development goals
(MDGs) by 2015 and becoming a middle-income country by 2025, the country performs much
effort and economic activities while faces some challenges.

Ethiopia has a vision of becoming a middle income country in the coming one and half decades
after implementing three successive five years development plan. At the end of the
implementation of the growth and transformation plan (GTP, 2010/11-2014/15), the aim is to
achieve MDGs. The development objective it to eradicate poverty in a relatively short period of
time by implementing broad based development polices to enhance growth.

1.2. Statement of the Problem

Ethiopia is one of the poorest country in the world with a population of more than 88 Million
(CSA, 2013) with subsistence agricultural sector. According to Alemayehu and Befekadu (2005),
Ethiopia’s history is full of conflict, drastic policy change and reversals.
However, in the last 10years the country shows little experience in economic growth . Even if
there are many unknown that causes for this little experience growth rate variables like ,
drought, famine, are the most important lists in this period and policy makers tried to found
other factors as well as other solutions .

Two decades ago, Ethiopian policy makers pursued a structural adjustment program which
shifted emphasis from public sector to private sector. The goal was to encourage private
domestic savings, private domestic investment and capital formation in order to enhance
economic growth. In an attempt to achieve this goal, resources were diverted from current
consumption and were invested in capital formation through privatization and commercialization
of state enterprises.

The economy of Ethiopia is growing fast with a double digit since 2004. In the year 2012 fiscal
year Ethiopia’s economy grew by 9.7% and the tenth year in a row of robust economic growth.
However, the African annual growth rate was 4.9% and that of Sub-Saharan countries was
5.3%for the same period (AFDB, 2012). According to African Economic Outlook report of
2012, Ethiopia was the 12th fastest growing economy in the world and the annual average real
GDP growth rate for the last decade was 10.9%. Moreover, the country’s aggregate economy
reached the sub-Saharan African 5th biggest economy.

So far, just there are many studies done on factors affecting Ethiopian economic growth. Yet
there is no comprehensive empirical study which determines factors affecting Ethiopian
economic growth that includes export, inflation, external debt, capital formation and human
capital. In this study, identifying the macroeconomic determinants of economic growth is a
majorstep to know factors responsible for the fast growth. Many studies have tried to identify the
major factors affecting economic growth in Ethiopia.

However, there are many macroeconomic variables including export, aid, inflation, and external
debt, which were not addressed in their studies. Therefore this study tries to fill this gab and
empirically analyze the selected macroeconomic determinants of economic growth in Ethiopia
during the specified period of time. Ethiopia has enjoyed improvements in its macroeconomic
performance in the past decade. In spite of being the second most populous country in Sub-
Saharan Africa, real GDP per capita has been steadily increasing in recent years.
According to National Bank of Ethiopia report (2013/14), the growth of GDP per capita rose to
USD 631 for the reporting period from USD 557 in the preceding year, registering
13.3%increase. GDP growth rates reflect this improvement, with average rates consistently
exceeding10 percent from 2004 to 2012. Along with this growth, however, the country has seen
an accelerated, double-digit increase in the price of goods and services. More recently, the
country faced a rising inflation problem. In 2008, inflation was reached at 29.1 percent and rose
to 36.4percent in 2009 (CSA, 2010).

Post reform (post 1992), the Ethiopian government has been introduced a free market economy
whereby the private sector would drive force in the economic growth. The huge public
investment which focuses on infrastructure and pro-poor sector explained much of the economic
performance from the expenditure side. Similarly the expenditure of socio-economic sector
(expenditure on education, health) has been increasing form time to time, which expected to have
a positive return to the economic growth in long run.
1.3. Objectives of the Study
General Objective
 The main objective of this study is to study and assess the critical overview of the
determinants of economic growth in Ethiopia in the specified periods.
Specific Objective
 To identify the major determinants of economic growth in Ethiopia between the periods
of 1984- 2013 through applying the OLS model
 To know the relationship among the identified variables.
 To discover the major solutions and actions that must be taken to speed up the process of
economic growth and continuity in Ethiopia.
1.4. Research Questions
This study basically focused on the macroeconomic determinants of economic growth, which
includes physical capital, human capital, export, aid, external debt and inflation; for this reason
the following questions should be addressed.
 What are the major determinants of economic growth?
 Which variable or variables more potent for economic growth in Ethiopia? To what
extent the variables affect the growth rate?
 Is there a long run relationship among the real GDP and the selected variable?
1.5. Significance of the Study
Identifying the sources of growth in Ethiopia is enormously important. But, researches in this
area are limited. If the country is to improve the lives of its citizens by alleviating poverty,
appropriate studies on the determinants of growth would immensely contribute by indicating
more relevant variables that are critical in ensuring sustainable growth and development.
Therefore, this study will serve as an input for policy makers and as a future focus area for future
research.

Most of the studies carried out so far in this area have dealt with the determinants of economic
growth that includes macroeconomic variable like physical capital, human capital, factors
affecting productivity (technology) and some other factors like rainfall. However, an ample of
empirical studies done in both developed and developing countries indicates that exports of
goods and services, Aid, external debt and inflation also affect economic growth in the long run.

Because one can be believe that a continuous and multi-disciplinary rigorous study is required to
take the policy implications seriously as relevant to Ethiopia. Therefore this study would tried to
provide comprehensive evidence on the selected macroeconomic determinants of economic
growth in Ethiopia during period of 1984 -2013.The issue of determinants of economic growth is
still on debate, therefore, the significance of this study is to provoke and lead a path for further
studies in the field. But its immediate outcome is for policy makers as a bench marks.

1. 6. Scope of the Study

This study tried to assess the sources of economic growth in Ethiopia for the period 1984-2013.
The variables which we used here are very few when compared to the several factors affecting
growth in Ethiopia this is for the sake of manageability. Time, finance, and inaccessibility of data
were the major constraints. Despite all these problems, the study have tied its best to effectively
utilize the available data and employed appropriate techniques in order to come up with reliable
findings.
1.7. Limitations of the study
The limitation of this study was the one associated with data availability. There are shortages of
data, particularly physical capital, specially, for the early period. The most challenge while
doing this study came from inconsistency of data from different organizations. So as to avoid
such inconsistency attempt is made to stick to the same source of data. The main aim of this
study is to analyze the macroeconomic determinants of economic growth. However, there are
also noneconomic factors that affecting growth like political stability, rules of economic
regulation (monitoring and fiscal policy), and rules of law (property right) are not addressed here
and might be consider other limitations of this study.
CHAPTER TWO: LITERATURE REVIEW
2.1. Theoretical literature reviews
Economic growth and the sources of differences in economic performance across nations are
some of the most interesting, important and challenging areas in modern social science. The
analysis of the process of economic growth was a central feature of the work of the classical
economists .Specifically, they were confronted with the fact of economic growth and social
changes taking place in contemporary English society as well as in previous historical periods.
According to Smith (1776), the importance of ‘invisible hand’ (the force of supply/ demand in a
competitive market), specialization /division of labor, accumulation of physical capital
(investment) and technological progress were the most determinants of economic growth in the
long term and hence the prosperity of nations.

A wide range of studies have investigated the factors underlying Economic growth. Using
different conceptual and methodological viewpoints, these studies have placed emphasis on a
different set of explanatory parameters and offered various insights to the sources of economic
growth.

The broad consensus highlighted in these studies is that a country’s growth over a long period is
Basically determined by three factors, namely: (1) the efficient utilization of the existing stock of
resources, (2) the accumulation of productive resources such as human capital, and
(3)technological progress (Dewan and Hussein, 2001, Ndambiri et al., 2012). Moreover, research
and development, economic policy and macroeconomic condition.

Openness to trade and institutional framework are among the most important determinants of
economic growth. These broad categories can be further broken down into various determinants
of economic growth. The influences considered here include human capital, physical capital,
exports, Aid, government policies, inflation, external debt, government expenditure, financial
systems and technological progress.

2.1.1 The neo-classical theory of Growth

The basic framework of neoclassical growth models was first developed by Robert Solow (1956)
and Trevor Swan (1956). This neo-classical model states that, at any point in time, the total
output of the economy depends on the quality and quantity of physical capital employed, the
quantity of labor employed and the average level of skills of the labor force. However, once the
economy reaches the full equilibrium level, additional growth in the stock of capital per worker
will only take place if productivity increases, either through enhanced capital stock or through
improvements in the quality of the labor force. The basic assumptions of the Solow model
include constant returns to scale, diminishing marginal productivity of capital, exogenously
determined technical progress and substitutability between capital and labor. And his basic
question was “what are the main determinants of economic growth in the long term”.

According the neo classical theory of growth, the model makes three important forecasts. First,
increasing capital relative to labor creates economic growth, since people can be more productive
given more capital. Second, poor countries with less capital per person grow faster because each
investment in capital produces a higher return than rich countries with sufficient capital. Third,
because of diminishing returns to capital, economies eventually reach a point where any increase
in capital no longer creates economic growth and which is called a steady state .the economic
growth model is extended as the following form. Thus;

y=f{Pk,Lf}--------------------1, where Pk and Lf represents

Physical capital and human capital, respectively.

2.1.2The Endogenous theory of Growth

In the mid-1980s it became increasingly clear that the standard neoclassical growth model was
theoretically unsatisfactory as a tool to explore the determinants of long-run growth .The main
limitation of the Solow model is that technological progress is assumed Exogenous and common
across countries (Elhanan Helpman, 2004).

The model without technological change predicts that the economy will eventually converge to a
steady state with zero per capita growth. The fundamental reason is the diminishing returns to
capital.

The basic improvement of the new growth theory or endogenous growth theory over that model
is that it explicitly tries to model technology rather assuming it to be exogenous. In essence, it
looks for determinants of technology frontier upward continuously. In this theory, the central
motive of profit maximization of business firms are considered to determine technological
progress as these firms involve in research and development (R&D) seeking new and better idea.
During the mid-1980s several economists, most notably Romer (1986) and Robert Lucas (1988),
sought to construct alternative models of growth where the long-run growth of income per capita
depends on investment decisions rather than unexplained technological progress.

Romer (1986) and Lucas (1988)) was developed an economic growth model that includes
mathematical explanation of technological advancement, which incorporates a new concept of
human capital (skill and knowledge) that make workers productive. Unlike physical capital,
human capital has an increasing rate of return. Therefore, overall there are constant rate of return
to capital and economies never reach a steady state. According to the Endogenous theory of
growth, economic growth does not slow as capital accumulation, but the rate of growth depends
on the type of capital a country invest in. As research indicates that increasing human capital
(education) and technological change (innovation) fast economic growth in long run (Elhanan
Helpman, HulyaUlka, 2004).

2.2 Empirical Literature Review

The Ethiopian economic growth has shown various changes in different political regimes. These
change in government structure created a problem of inconsistency in implementing the policies
by previous regimes including external and internal wars as well as natural disaster like famine
and drought had a depressing effect on the history of economic growth of the country.

In modern Ethiopian political economic history, we can distinguish three regimes that followed
unique macroeconomic policies with its impact on macroeconomic growth performance of the
country. These are the period of pre 1974(the monarchy regime), the period 1974-1991(the
military regime) and 1992 to the present (the EPRDF regime). Ethiopia’s economic policy
history is characterized by several radical policy changes and blows. During the monarchy
(pre1974) economic policy was mainly known to be a market-oriented economic system.
However, the period 1974–1991 characterized by centralized and command economic system.
Since 1992EPRDF officially denounced the socialist system and supported market-oriented
economic system.

Alemayehu and Befekadu (2005) stated that “cyclical political processes and regime shifts Were
unpredictable and violent with negative consequences on the economic performance of the
country. Economic insecurity pervades the systems as a rule of law, and enforcement of contracts
and property right insecurity are configured on an unstable political base.”Here we summarize
the descriptive analysis of economic performance of the country by using secondary data in
different regime as follows.

2. 2.1. The Socialist {Derg} Regime 1974-1991

Under the Provisional Military Administrative Council (PMAC; also known as the Derg),
Ethiopia’s political system and economic structure changed dramatically, and the government
embraced a Marxist-Leninist political philosophy. Planning became more ambitious and more
pervasive, penetrating all regions and all sectors of the society, in contrast to the imperial period.
By all measures they embraced a “hard control” during this regime. The average rate of growth
of gross domestic product (GDP) and the per capita term was 1.6% and -0.7%, respectively
(Eshetu and Mekonnen, 1992) during 1974-1990 and this growth rate was far below the
estimated population growth of 2.5%. However, in 1984 and 1985, the GDP growth rate began to
decelerate, amounting to -5.3%, which means that the per capita GDP was -10% in the same
period.

Similarly, Alemayehu and Befekadu (2005), reported that economic growth was decelerated to
2.3 percent (-0.4 percent in per capita terms) between 1974/75 and 1989/90. Reports of EEA
(2007/08) indicates that, the average annual growth of GDP and GDP per capita were 2% and
0.5%, respectively during the entire period of derg (1974-1991). The sectoral growth rate of
agriculture, industry and service sector were 1.3, 1.4 and 3 percent, respectively during the same
period.Table-During 1974-1978, GDP grew only by 0.4 percent, because this period was a
period of Intensive internal conflicts and war with Somalia. However, during 1979-1983 there
was aPeriod of recovery, in which GDP registered a respectable growth rate of 4.2 percent.

As weknow this period was named ‘zemecha year’, when an all-out (greatest possible) efforts
were made to boost production (Eshetu and Mekonnen, 1992) on the basis of annual
development campaigns. In 1984 and 1985, the period of catastrophic drought and famine, in
which GDP and GDP per capita actually declined by 5.3 and 8.5 percent, respectively, with
disastrous consequence for the economy and society. Despite the fluctuate economic growth in
the regime(Derg), we find that 1986-1987 was the period of recovery, in which GDP and GDP
per capita grew by 7.9 and 4.7 percent, respectively (the highest economic growth in the regime),
largely as result of best rain seasons.
In general, during the entire period of military regime, both growth rate of GDP and GDP per
capita were far below the estimated average population growth of 2.5 percent. To sum up, the
military period was characterized by: very low economic growth moreover, extremely irregular
growth; there was high rate of governmental consumption; the external debt position was also at
an alarming rate of which financed to military force 40-50 percent (Tadesse, 2011); there was
full of conflict both with internal and external parties (unrest); and many other problems were
affect the economic growth badly.

2.2.2. The EPRDF Regime (Since 1991)

This period begins following the accession to power of the Ethiopian People Revolutionary
Democratic Front (EPRDF) in May 1991, following the demise of the Derg. The EPRDF
adopted the typical structural adjustment policies of market liberalization, which issued a new
economic policy in November 1991 by openly a market-oriented economic policy Alemayehu
and Befekadu (2005). Over the last two decades, the Government of Ethiopia (GoE) has been
implementing a development program aimed at poverty reduction through rapid economic
growth and macroeconomic stability.

The country has recorded strong economic growth over the past decade, mainly due to the
Government-led development policies emphasizing public investment, commercialization of
agricultural sector and non-farm private sector development . EPRDF accepted the reform to get
external endorsements (in the face of domestic opposition) and to use macro policy instruments
(such as fiscal decentralization) to fight the hostile bureaucracy and promote equitable
distribution.

In addition to these political factors the government accepted the reform to stimulate the crippled
socialist economy by encouraging the participation of private sectors. On wards the reform the
government promoted domestic private sector and opened the door to foreign investors, except in
the financial industry. The major policy reforms of post EPRDF includes: (1) Domestic and
external trade liberalization; (2) Financial sector liberalization (only for local investor) and labor
market liberalization; (3) Liberalization of the product market, in particular the agricultural
sector; (4) Pursuing conservative fiscal and monetary policy (minimization of expenditure and
switching, tax reform, tight monetary policy, exchange rate and public sector reform) were the
most one (Tadesse, 2011). Since 1992, the government began to implement an economic reform
years of civil war, food security crises, heavy central planning and more.

2.3 .Macroeconomic Performance

2.3.1. Physical Capital Accumulation versus Economic Growth

Theoretically the relation between capital formation and growth can be explained by ‘Q’ theory.
As per this theory capital formation acts as the main driving force of economic growth. Capital
formation refers to the proportion of present income saved and invested in order to enhance
future output and income. It usually results from acquiring of new factory, machinery, equipment
and all productive capital goods. The rate of accumulation of physical capital is one of the main
factors determining the level of real output (GDP). Basically capital acts as the most fundamental
input in a production system. It provides the base of growth of an economy.
There exists a non-linear positive relation between capital formation and growth in general
depending on the degree of efficiency of the capital use within the economic system. So the level
of capital used within the economy is not only important but also the way it is used is also an
important determinant of economic growth.

Though there is rich literature on determinants of economic growth, little has been done in
Ethiopia. Some of those have done on the macroeconomic performance rather than on the
determinants of economic growth. Recent works in economic growth in Ethiopia were the
studies done by Seid (2000); Weeks et al. (2004) and Tadesse (2011) were the best one.
According to Seid (2000) study done on the Ethiopian economic growth during the period
1960/61 and 1998/99 by applying methods of Johansen co-integration, fixed capital formation is
statistically insignificant. Rather the main finding or determining factor is that economic growth
in Ethiopia were rainfall, export level and labor force in log run.
However the research conducted by Tadesse (2011) during 1981 and 2009 found that the
economic growth in Ethiopia was driven by physical capital and human capital, which account
42 and 56 percent, respectively. On the other hand a research done in Ethiopia (Weeks et
al.,2004), indicates that the contribution of physical capital to growth is found to be statistically
significant in short run despite the growth elasticity was less (0.30) comparing to Tadess’s result
(i.e. 0.42).
2.3.3. Export versus Economic Growth
Exports of goods and services represent one of the most important sources of foreign exchange
income that affluence the pressure on the balance of payments and create an employment
opportunities. An export led growth strategy aims to provide producers with incentives to export
their goods through various economic and governmental policies. It is important to note that a
large number of studies on the importance of exports in economic performance and the
relationship between exports and aggregate economic activity (economic growth) have been
conducted over the years, particularly in recent years. It is gratifying to observe that in recent
times, there has been great and increasing interest in the study of exports and economic growth
within the context of developing countries.
When we come to Ethiopia, the research result was inconsistent. A research done by Faye (2001)
indicates that there was a positive and significant impact between export and economic growth in
the Ethiopian context. According to his result, the rate of real growth rate of real export has
positive effect on the rate of economic growth. Not only this but also he found that, there was a
strong positive relationship in the long run than in the short run. Similarly, a study done by
Soressa (2013) Applying the Autoregressive distributed lag model (ARDL) and Grange causality
for the period 1960 to 2011 found that, a one percent increase in export will lead to increase the
economic growth by 0.57 percent in long run. Moreover, the research done by Hailegiorgis
(2012) during 1974 to 2009 by using granger causality found that, there is an evidence of
unidirectional causality between export and economic growth in Ethiopia (I.e. export growth
causes economic growth).
However, the study of Gezahegn (2012), which was conducted during 1981 to 2011 that
analyzed the long run effect of export volatility on economic growth, was inconsistence with the
above studies. According to the study empirical finding, the long run effect of export volatility
seems to have negatively statistical effect on output growth on Ethiopia. In addition the study
found that export was insignificant to the Ethiopian economic growth even though there was a
positive relationship between export and economic growth during the study period.
 2.3.4. External Debt versus Economic Growth
Most developing countries, especially developing countries in Africa faced domestic financial
constraints. Those constraints made external debt an essential complement to domestic resources
for promoting sustainable economic growth among these developing countries. The theoretical
literature suggests that foreign borrowing has a positive impact on investment and growth up to a
certain threshold level; beyond this level, however, its impact is adverse. According to the
empirical evidence of many developing countries including Africa and Latin America a
reasonable external debt accelerates economic growth. However, beyond certain threshold level,
additional indebtedness may reducegrowth.
high level of external debt led to devaluation of the nation’s currency, increase in retrenchment
of workers, continued industrial strike and poor education system. In addition the IMF working
paper (2002) from 19691998 based on panel data of 93 developing countries, a reasonable level
of external debt help finance productive investment and expected to enhance growth but beyond
certain threshold level, additional indebtedness may reduce growth. A country with average
indebtedness and doubling the debt ratio to real GDP would reduce annual per capita growth by
0.5% -1%.
In Ethiopia the study shows for the last recent four decades by Teklu et al.(2014), reported that
the ratio of public external debt to GDP has negative and statistically significant relationship
with real GDP in the long run and had no significant effect in short run. A stud by melese (2005)
conducted in Ethiopia during 1970-2002 using a structural
Macroeconomic model found that; all the debt burden indicators have a negative relationship
with economic growth. Similarly, Hailemariam (2011) examined the impact of external debt on
Ethiopian economic growth and private investment in Ethiopian applying a vector autoregressive
(VAR) model over the period of 1960/61 –2008/09. The study found that in the long run both
external debt stock as well as debt servicing ratio have a negative and significant impact on
economic growth and private sector capital accumulation activity.
However, in the short run external debt and economic growth have positive relationship. He
conclude that, the estimated short run models points out the current level of external debt flow
has a positive while the past debt accumulation has a negative impact on economic growth and
private investment of Ethiopia.
The other recent study done in Ethiopia, which analyzed the effect of external debt on Ethiopian
economic growth (Wessene, 2014) by applying ARDL model during the period of
1970/712010/11 was found that there is a negative and significant relationship between external
debt and economic growth in long run.
2.3.5.Inflation Versus Economic Growth
Currently, the word inflation is a major problem of the world. It is a monster that threatens all
economies because of its undesirable effect and developed countries named as number one
public enemy in the 21thcentury (Asmamaw, 2011). According to classical theories inflation
occurs in an economy when the overall price level increases and the demand of goods and
service increases. Based on the Keynesian theories inflation occurs when demand exceeds the
potential output of the economy. In 1960s, inflation and growth were positively related in the
short run. Even in the long run, Tobin (1965) and Sidrauski (1967) suggested a positive effect on
growth from higher inflation. When inflation was high, wealth would be reallocated away from
money and into physical capital.
A study conducted in 140 countries (both developed and developing) during 1960-1998
(KhanandSenhadji, 2000) found out that the threshold inflation level for industrial countries and
developing countries were 13 percent and 11-12 percent respectively, under the study period.
Similarly, a study conducted in Nigeria Bawa and Abdullahi(2010) during 1981-2009 based on
the quarterly data and by using the threshold regression model found out that the threshold
inflation level was 13 percent. In addition their finding indicates that below the threshold level,
inflation has a mild effect on economic activities, while above it, the magnitude of the negative
effect of inflation on growth was high research done by Barrob (2013) in 100 countries of the
world including Ethiopia from 1960 -1990, indicates that an increasing in average inflation by
10% are likely reduce the growth rate of real per capita GDP by 0.2 to 0.3 percentage and reduce
the ratio of investment to real GDP by 0.4-0.6percentage per year.
Similarly the study done on 15 Sub-Sahara Africa by Veiga et al.(2014) showed that a unit
percentage rise in inflation will reduce the growth rate by 1.5% in the region. Not only this but
also the study of Asmamaw (2012) in Ethiopia have similar result. According to his research
result, which was based on time series data from 1974-2011 applying VAR methodology, a unit
percentage rise in inflation will reduce the GDP growth by 0.178% in log run.
2.4 Conceptual frame work

Different macroeconomic variables have a multi-dimensional relationship in nature that

determines level of economic growth (real GDP) positively or negatively.
Total export
Gross capital Expand export
formation Incr Moti
eas vate
e expo
rt

Inflation
Increase REAL GDP

Affect
positively
or
negatively

External debit

Most of the time literatures done in economic growth are theoretical in nature and uses droght,
famine and the like variables to analyze the level of economic growth as a determinant and we
have tried to address the major macro-economic variables as a determinant of economic growth
and their empirical relationships with each other.
CHAPTER THREE: METHODOLOGY OF THE STUDY
3.1 Type of data and source

We have used secondary time series data that determines the economic growth in Ethiopia. And
we tried to assess or search the source of data from different organizations like NEA, WB, CSA,
and MOFED via with the help of internet.

3.2Variable description

Real GDP (Y)

is the market value of the goods and services produced by an economy over time. It is conventionally
measured as the percent rate of increase in real Gross Domestic Product. Since most economists argue
that economic growth can be measured as growth in real GDP, it includes in the model as main dependent
variable in order to measure economic growth. In order to avoid the inconsistency associated with
different base year price while computing real GDP, this study was used the real GDP (constant value),
which is deflated by Ministry of Finance and Economic Development (MoFED) based on the constant
price of 2010/11.

Gross capital accumulation (GCF)

is defined as Gross capital formation (formerly gross investment) in a country. However, getting such a
readymade time series data in Ethiopia is difficult. Therefore in this study, gross investment was used as
proxy of this variable and have been expected a positive impact on economic growth.

Exports of goods and service (EXT)

are defined as the total exports of goods and service to the rest of the world. It is believed that export of a
country’s is one of the macroeconomic determinants of economic growth. For this reason and due to
researcher’s interest this variable is entered as explanatory in order to analyze it effect on Ethiopian
economic growth. The expected sign of this variable is expected to be positive.

External Debt (ED)

is defined as net in currency of government liabilities. Even though there is fast economic growth,
Ethiopia is challenged in financial problem to finance its mega project. For this reason the Ethiopian
external debt will increase from time to time. As a result, it is the researcher’s interest to include in this
study in order to analyze its effect on economic growth and would be expected a negative sign.
General Inflation (INF)

Inflation is defined as an increase in the overall price level in a country and measured in percent. In
Ethiopian history inflation was not a problem of economic growth. However, starting 2008 it is a serious
problem. Therefore to analyze its effect on economic growth, it is the other interest of the researcher’s,
which is included in this study as independent variable. The coefficient of this variable would be expected
a negative sign.

As we discussed earlier, this study was used annual secondary data from 1984 to 2013 sourced from
Ministry of Finance and Economic Development (MoFED); National Bank of Ethiopia (NBE); Central
Statistical Agency (CSA) and World Bank Indicator (WBI). Except inflation, all the variables are
measured in millions of Birr

3.3.Methods of data analysis

The model in this research mainly contains the macro variables of the determinants of economic
growth in Ethiopia. The methodology for analyzing the data includes both descriptive statistics
and econometrics regression analysis. Descriptive statistical tools, graph and percentage.
An ordinary least square (OLS) estimation technique is used in this paper to estimate the model.
The reason why the we used OLS estimation technique is that, the parameters obtained by this
method have some optimal properties that are Best Linear Unbiased Estimation (BLUE). The
other reason is the procedure used in OLS are simple than other estimation methods (Gujarati,
2004). The regression analysis is used to identify the magnitude of the determinants is measured
by using linear regression equation. When we use a time series data in estimation, the estimation
first thing is the test of stationarity in order to eliminate the possibility of spurious regression
results.
Finally Basic econometrical technique which is listed in estimation procedures will apply to
analyze the major determinants of economic growth under the study periods which are listed in
estimation procedures. Finally, Micro fit versions have been used as statistical software package
for the entire analyze running this study.

3.4. Model specification

In this chapter we have tried to saw a simple linear growth model that attempts to capture some
of the major macroeconomic factors affecting economic growth in Ethiopia that includes export,
aid, inflation, external debt, capital formation and human capital formation. Understanding
characteristics and determinants of economic growth requires an empirical framework that we
have applied a relatively long time frame. In order to examine the empirical evidence of the
macroeconomic determinants of economic growth in Ethiopia, the study were considered most of
these factors in the theoretical literature review& origin of the econometric model is extended
neoclassical growth model. Thus:

Y=f(pk ,Lf)………………….{1}

Where Pk and Lf represents Physical capital and human capital, respectively .By extending the
approach of neo classical growth model, that we specified the economic growth function for
Ethiopia as follows: Real GDP is a function of physical capital, human capital, exports of goods
and service, foreign aid, external debt and inflation.

Therefore the mathematically relationship between real GDP and its major macroeconomic
determinants were expressed as follows:

Y=f( CGF, EXT, EXD,INF)………………….(2)

all the variables under study are transferred into Log data to avoid hetroscedasticity and to show
elasticity of the variables; and the growth function of equation [2] ;was expressed as,

LnY=C+ß1lnGCF +ß2lnTEX+b3lnEXD+ß4INF....+e

Where

LnY represents the natural logarithm form of dependent variable of real GDP;

LnGcf represent the natural logarithm form of explanatory variables of physical capital
(formally gross investment)

LnEXT stands for the natural logarithm form of explanatory variable of total export;

LnEXD represents the natural logarithem form of explanatory variable for external debt

INf represents explanatory variable of general inflation;.

e ,represents The error term ( assumed to be normally and independently distributed with zero
mean and constant variance, which captures all other explanatory variables which influences real
gross domestic product in a country which are not captured in the model. are the partial
elasticity’s of real GDP with respect to macroeconomic variables listed above.
3.5. Estimation test

The Unit Root test

The first step in time series Regression analysis is to test stationarity of each variable. The need
to test stationarity of the variables arises because estimating regression using non-stationary base
on OLS leads to spurious and in consistent result (Gujarat, 1995). In addition, if variables are
non-stationary it is difficult to conduct hypothesis testing as the classical assumption on the
property of the error term namely that it has zero mean, constant variance, and non-auto
correlated is violated (Rao, 1994). Therefore, stationary test is important.
There are different ways of testing stationary. In this research, widely applicable (and most
available in statistical software) test of unit root, namely the Augmented Dickey-Fuller (ADF)
test will used. It is known that most time series variables are non-stationary at level. Differencing
the respective variables and running regression on the same can handle the non-stationary
problem. However, this method suffer from the problem that information about the long Run
relationship between the variable is lost, sine in the long run first difference of these variable are
zero (Yuanan, 1994).
Multicollinearity tests
The term multicollinearity refers to the situation where there is either an exact or an
approximately exact linear relationship among the x variables. The variance inflation factor(VIF)
is the test of Multicollinearity. Some authors therefore use the VIF as an indicator of
Multicollinearity. As a rule of thumb the largest the value of VIF or if the value of the variable
exceed 10 the more will be the degree of co linearity of the variable with the other repressor
Autocorrelation tests
The term autocorrelation may be defined as a correlation between members of series of
Observations ordered in time (as in time series data) or space (as in cross sectional data
 CHAPTER FOUR: RESULT AND DISCUSSION
Our result and discussion were organized by both theoretical and empirical analysis. And We
have tried to use line graph and bar graph to theoretical part of analysis and we employed tables
and regression results to empirical analysis.

4.1. THEORETICAL ANALYSIS

4.1.1 GROSS CAPITAL FORMATION

Even though countries economic growth is significantly affected by the rate of investment.
However gross capital formation as a share of GDP in Ethiopia is low. As have seen that most of
the time the growth rate investment was much higher than gross domestic saving
(EEA2005/06). As a result, the resource gap was, on average, -15.4 percent over the last fifteen
years, which was financed by external sources.

similarly, MoFED (2013) also reported that, domestic saving was small (10.6%) while gross
investment rate was 26.9 percent during 200/01 to 2011/12.Accordingly, the resource gap of the
country registered 18.1te percent as ratio of GDP during the same period, and which was
financed primarily from foreign source (specially, from external debt during 2000 to 2003 and
2007 to 2010 while during 2004 to 2005 was primarily from internal debt.

According to the GTP, gross capital formation (formally gross investment) was expected to take
30 percent of GDP share while it reaches 40.3 percent during 2013/14 (NBE, 2013/14), which
was achieved before the GTP period completed. Despite, the gross domestic saving rate
registered 22.5 percent of GDP share, which is above the GTP target (15%) and even achieved
before the period is completed, still it very low as comparing to the investment rate needed.
During 2009/10, domestic saving was only 5.2 percent of GDP.

However, during the past 4 GTP periods domestic saving started to take off; as a result the share
has jumped to 22.5 percent in 2013/14. For the amazing growth of domestic saving rate, the
government introduced to stimulate domestic saving including wide range of awareness creation
activities in urban and rural areas of the country; strengthening existing saving tools and
introduction of new saving mobilization instruments such as selling of government Bonds,
deepening of financial institutions, introducing private social security scheme, strengthening
government workers social security scheme, strengthening saving for housing program, saving
for investment equipment scheme, and sustaining the high level of government saving. Thus,
expansion of investment over the past years has been one of the key drivers of growth on the
40
30
gcf%gdp
20
10

1980 1990 2000 2010 2020

year
demand
side.Figure4.1 trend of gross capital formation in Ethiopia

Source: own computation using 1984 -2013 time series data

4.1.2 EXPORT AND ETHIOPIAN ECONOMY

Export and The export sector has played an important role to bring about rapid economic growth
in developing countries. However, most of them largely depend for their source of currency
earning on a single product or a very narrow range of low value products, mostly agricultural
commodities and minerals. Likewise, the Ethiopian commodity export sector is basically
characterized by the dominant share of agricultural raw commodities in generating the greater
proportion of the export earning of the country. These export commodities together have
accounted more than 86 percent (NBE, 2012/13) of the total merchandise export earnings. The
major export items, in order of their significance in the total commodity export value include
coffee, gold, oil seeds, hides and skins, pulses, chat, flower, fruits and vegetables.
The total amount of export value increased to 10,136 Million Birr in 1984 at constant value. In
the year 1984, however, it was fluctuated and starts to decline and reached 4,727 Million Birr in
1991. After the reform period i.e. 1992, export earnings increased with little fluctuations and
recorded 122,632 Million Birr in2013 Ethiopian Economy.
12
11
lntex
10
9

1980 1990 2000 2010 2020

year

Figure4.2Trend 0f total export on Ethiopian economy

Source, own computation from( stata12)

4.1.3. External Debt and Ethiopian Economy

Ethiopian external debt stock has shown significant change in its size over the years under
consideration. Its external debt is steadily increasing specially, since 2007. According to the
UNDP country report (2012), the Ethiopian external debt reached $11.1 billion or 24.3 percent of
GDP during 2013 from $2.7 billion in 2006. While the real GDP growth registered 9.7 percent
for the same period (GDP per capita reached 550 USD from 270 USD) in 2006..
 12
11
lnexd
10
9
8

1980 1990 2000 2010 2020

year

Figure 4.3 .trend of external debit on economic growth

Source, own computation

Ethiopia is one of the Highly Indebted Poor Countries (HIPC) in the world. As we have seen in
Figure 4.3above, the external debt continually at increasing rate since 2007. The economy also
grew at an average of double digit (11.4 percent)for the same period. Form this we can observe
that as the external debt increase the growth also raises, which indicates that the external debt
were invested in the macroeconomic development rather for recurrent consumption despite they
have inverse relationship between growth and external debt.

4.1.4Trends of Inflation in Ethiopia

Trends of inflation show the change in the inflation over the years. Looking at the trends of the
Inflation would enable the reader to understand the change of inflation during the study periods.
Ethiopia has recorded strong economic growth over the past 10 years mainly due to the
Government-led development policies emphasizing public investment, commercialization of
agriculture and non-farm private sector development. Inflation remained at a reasonable low
level rate before 2000/03. However, post 2003/04 sow sharp increase despite rapid economic
growth during the same .the sharp increasing of general inflation was caused primarily by food
inflation, which is the effect of food demand triggered and international food price hike.

The official headline inflation during 2008 stood at about 25 percent with food inflation being 49
percent. This was huge macroeconomic shock in the history of Ethiopia for the last five decades
and until 2003, was below 5 percent per annum. This high rate of inflation continued until
2011/12. The 12 month moving average general inflation rate, which shows a longer inflation
situation, was 18 percent for June 2010/11 and 34 percent in June 2011/12.

According to the MoFED report (2012/13) the high inflation rate, particularly in the year 12
adversely affected the wellbeing of people and the effect to promote private investment. As a
result, the Ethiopian government had taken policy measurements (prudent fiscal and monetary .
Consequently, as of June 2012/13, the general inflation declined to 13.5 percent. As the National
Bank of Ethiopia report indicates (2013/14), the general inflation declined from 13policy) and
price stabilization intervention2012/13 to 4.1 percent in2013/145 percent in

Generally, we can say that, in the Ethiopian history inflation was at reasonable low level (i.e., is
to initiate facilitate economic growth in Ethiopia under private sectors . dose not harm the
economy significantly) except for the period 2008-2012 .Beside its stability is the most engine
to initiate facilitate economic growth in Ethiopia under private sectors .
 40
30
20
inf%
10
0
-10

1980 1990 2000 2010 2020

year
.

Figure4.4 .Trend of inflation in Ethiopia economic growth

Source,own computaion from (stata 12)

4.2.Empirical results discussion

Since we have specified the growth model in log-linear form, the coefficients can be interpreted
as elasticity with respect to real GDP.

LRGDP=7.752+0.312GCF+0.432LTEX-0.049LEXD+0.002INF + e

Teble 4.1 Determinants of economic growth in Ethiopia regression result

Source | SS df MS Number of obs = 30- F( 4, 25) = 306.95

Model | 8.10410235 4 2.02602559 Prob > F = 0.0000

Residual | .165014068 25 .006600563 R-squared = 0.9800

-------------+------------------------------ Adj R-squared = 0.9769

Total | 8.26911642 29 .285141945 Root MSE = .08124

lnrgdp | Coef. Std. Err. t P>|t| [95% Conf. Interval]

-------------+----------------------------------------------------------------

gcf%gdp .031256 .0069536 4.49 0.000 .0169348 .0455772

lntex .4327267 .0691198 6.26 0.000 .2903718 .5750815

lnexd -.049226 .0316424 -1.56 0.132 -.1143947 .0159428

inf .0027854 .0016111 1.73 0.096 -.0005327 .0061035

_cons 7.752337 .4453227 17.41 0.000 6.835178 8.669497

Source .own computation of time series data(1984-2013), stata12

R2=98%, it implies the explanatory variable correctlyexplain the model by 98%.

result of Table 4.1 indicates that all the variables entered in the regression have the expected signs
regardless of their significant level. As we have discussed in the theoretical and empirical literature parts,
gross capital capital formation, exports of goods and service, and inflation have positive impact on
Ethiopian economic growth.

While external debt have an inverse negative impact in Ethiopian economic growth with insignificant
condition .

LRGDP=7.752+0.312GCF+0.432LTEX-0.049LEXD+0.002INF + e

Since we have specified the growth model in log-linear form, the coefficients can be interpreted as
elasticity with respect to real GDP. The coefficient of gross capital formation(GCF) is 0.2998.holding
other things constant, a one percent(1%) change in gross capital formation which is peroxided by gross
investment brought 0.2998 percent change in real GDP during the study period.

This positive result is due to the past 4 GTP periods domestic saving started to take off; as a result the
share has jumped to 22.5 percent in 2013/14. For the amazing growth of domestic saving rate, the
government introduced to stimulate domestic saving including wide range of awareness creation activities
in urban and rural areas of the country; strengthening existing saving tools and introduction of new saving
mobilization instruments such as selling of government Bonds, deepening of financial institutions,
introducing private social security scheme, strengthening government workers social security scheme,
strengthening saving for housing program, saving for investment equipment scheme, and sustaining the
high level of government savings. Thus expansion of investment over the past years has been one of the
key drivers of growth on the demand side.

The result of this study revealed that the impact of total exports of goods and service on Ethiopian
economic growth during the study period .A one percent(1%) increase in total export the growth of
reaGDP is increased by 0.31%.

This result also confirmed by MoFED particularly during 2011/12 and 2012/13 despite it was
expected to play an important role in accelerating the economic growth during the GTP period. total
exports of goods and service was positive impact in Ethiopian economic growth .while there is an inverse
relationship between economic growth and export volatility.

Test of Stationary and Non-Stationary Series

Empirical works based on time series data assumes that the underlying time series is stationary.
However, most of macroeconomic time series data are non – stationary. Therefore, in economic
research involving time series data, before any kind of statistical estimation takes place the data
for variables in the model should be tested for stationary. A stochastic process is said to be
stationary if its mean and variance are constant over time and the value of the covariance
between the two time periods depend only on the distance or gap or lag between the two time
periods and not the actual time at which the covariance is computed (Gujarati, 2003)

Testing For Unit-Roots

Unit-roots are important to detect the stationary of time-series data. If the series have unit-roots,
we apply a test of Augmented Dickey-Fuller test is a similar but modified version of the Dickey-
Fuller test that uses when the error term is not a white noise. While testing for stationary, if a
variable becomes stationary at level, then it is said to be integrated of order zero, I(0). In
addition, if the variable is stationary at its first difference, it is said to be integrated of order one I
(1). Similarly, if a variable can be transformed to Stationary series by differencing n times, then
it is integrated of order n, I (n). (Verbeck, 2004) .

Table 4.2. Augmented Dickey fuller unit root result table

variables t-stastics Critical

 1% 5% 10%

GCFF%GDP -3.958433 -3.669871 -2.976263 -2.627420

lnTEX -3.848979 -3.699871 -2.976263 -2.627420

lnEXD -3.7553672 -4.323979 -3.580623 -3.25334

INF 2.971853
2.864183 3.6899194 2.625121
2.627420
lnRGDP 2.993073 3.699871 2.976263
Source: own computation (eview result)

As we have seen form table4.1, GDP (LRGDP) , Groos capital formation (LGCF), export (LEXT)
are stationary at first difference with constant while, external debit (LEXD) and general inflation
(INF) are stationary at level with constant and trend, and with constant respectively. In addition to
this all variables are stationary at first difference with constant.

Multicollinearity tests
The term multicollinearity refers to the situation where there is either an exact or an
approximately exact linear relationship among the x variables. The variance inflation factor(VIF)
is the test of Multicollinearity. Some authors therefore use the VIF as an indicator of
Multicollinearity. As a rule of thumb the largest the value of VIF or if the value of the variable
exceed 10 the more will be the degree of co linearity of the variable with the other repressor. On
the other hand if the VIF is less than 10 the greater the evidence that variable is not collinear
with other repressor (Guajarati, 2004).So there is no multicollinearity problem among two
explanatory variable because all the variables, its VIF is less than10.

Table4.3 multicollinearity test

Variable | VIF 1/VIF
-------------+----------------------
 lntex | 14.43 0.069308
gcfgdp | 10.28 0.097295
lnexd | 6.40 0.156341
inf | 1.41 0.710415
-------------+----------------------
Mean VIF | 8.13
Source; own computation (stata12)
so even if there is multicollinearity problem between two exogenous variables, on average the
mean value of VIF of the variables are below the boundary point of multicollinearity that is
8.13<10 .so the effect of multicollinearity problem is not that much.
Autocorrelation tests
The term autocorrelation may be defined as a correlation between members of series of
Observations ordered in time (as in time series data) or space (as in cross sectional data). So
there is no auot-ocorilaton problem because its Durbin Watson d statistics is between 0 and 4,
and if its value approaches to 2 it is better. The value of tests that we have found in Dubbin-
Watson d-statistic is ( 5, 30) = 1.444657 which is almost good.
Hetroskedasticity test
Breusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance
Variables: fitted values of lnrgdp
Chi2(1) = 0.10
Prob >chi2 =0.7578, sourse ;own computation(There is no hetroskedasticity problem in our
finding result. the probability is greater than chi(1). That is 0.7578>0.10 and the value lies above
0.05.

CHAPTER FIVE: CONCLUSION AND RECOMANDATION

5.1. Conclusion

As we have dealing in the theoretical analysis gross capital formation contributes a great share to
real GDP. Through government efforts of strengthening existing saving tools and introduction of
new saving mobilization instruments such as selling of government Bonds, deepening of
financial institutions, introducing private social security scheme, strengthening government
workers social security scheme, strengthening saving for housing program, saving for investment
equipment scheme, and sustaining the high level of government saving. Thus, expansion of
investment over the past years has been one of the key drivers of growth on the demand side.

During the study period. Our empirical result showed that physical capital (gross investment)
found to have positive impact on Ethiopian economic growth. A one percent increase in capital
formation (gross investment) results in 0.31256 increases in real GDP.

As we have seen in the theoretical review external debt continually at increasing during the study period.
The economy also grew in a small proportion. Form this we can observe that as the external debt increase
the growth also raises, this conditions is satisfied only when the external debt were invested in the
macroeconomic development rather for recurrent consumption. Otherwise they have inverse relationship
between growth and external debt. Empirical result shows that The external debt also has negative
insignificant impact in economic growth during the study period .A one percent increase in
external debt will result in -0.49226 decline in real GDP.

However, the study found out that total export of goods and service and inflation have positive
impact on economic growth with positive sign.

Generally, we can say that, in the Ethiopian history inflation was at reasonable low level (i.e., dose not
harm the economy significantly) except for the period 2008-2012. Beside its stability is the most engine
to initiate facilitate economic growth in Ethiopia under private sectors .

During the study period growth is relatively fast and beyond satisfactory. The average growth
rate in real GDP registered 6.7 percent (real GDP per capita was 3.4%) during 1992 to 2013. the
growth rate in real GDP on average registered 10.9percent (NBE, 2013/14) and by far more than
the average growth rat for sub-Saharan countries.

5.2. Recommendation
Based on findings in our study that we have carried out we have suggested some possible
instruments as a policy recommendation to be done to enhance the contribution of macro-
economic variables that we have used in our study and create sustainable economic growth in
Ethiopia.

As we have we have studied in both theoretical and empirical analysis Gross capital formation
have strong positive significant impact on Ethiopian economies.so In order to enhance the
contribution of the physical capital formation, the government of Ethiopia has to set policies to
increase domestic saving which is believed as a back bone of growth. This includes increase
saving mobilization like selling of government Bonds, expanding financial institutions and by
strengthening existing saving tools (strengthening both private and government workers social
security scheme, strengthening saving for housing program, saving for investment equipment
scheme).

Our result and discussion shows that Exports of goods and service have significant positive
impact on Ethiopian economic growth. Therefore, the Federal Government of Ethiopia should
strengthen the existing strategies in export development and promoting investment particularly in
the manufacturing sector for export and import substitution. Moreover it is recommendable that
policies that facilitate flexibility in Production for exports would be outlined

As we have seen that debt affects the economic growth of Ethiopia negatively in our study, The
government should allocating resources on selected productive investment areas, which used to
return back the debt burden and together with basic infrastructure construction that facilities
productive of other sector is decisive. In addition there should be close monitoring and consistent
debt management strategies, which is used to avoid mis allocation and mismanagement of
external debt problem.

Both our the theoretical and empirical study shows inflation is not that much a problem in
Ethiopian growth, the federal government should work to reduce the inflation rate if possible,
otherwise, it should sustain the existing inflation rate (with single digit) by tight fiscal and
monetary policies, financing of budget deficit from non-inflationary sources and implementation
of price stabilization program by subsiding basic food items
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 Befekadu D. and Birhanu N. (1999/2000), “Annual report on Ethiopian economy”,

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Appendix

APPENDIX A
___ ____ ____ ____ ____ (R)
/__ / ____/ / ____/
___/ / /___/ / /___/ 12.1 Copyright 1985-2011 StataCorp LP
Statistics/Data Analysis StataCorp
4905 Lakeway Drive
Special Edition College Station, Texas 77845 USA
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979-696-4601 (fax)
Single-user Stata network perpetual license:
Serial number: 93611859953
Licensed to: STATAforAll
STATA
Notes:
1. (/v# option or -set maxvar-) 5000 maximum variables
. *(1 variable, 30 observations pasted into data editor)
. *(5 variables, 30 observations pasted into data editor)
. tsset year, yearly
time variable: year, 1984 to 2013
delta: 1 year
. regress lnrgdp gcfgdplntexlnexdinf
Source | SS df MS Number of obs = 30
-------------+------------------------------ F( 4, 25) = 306.95
Model | 8.10410235 4 2.02602559 Prob > F = 0.0000
Residual | .165014068 25 .006600563 R-squared = 0.9800
-------------+------------------------------ Adj R-squared = 0.9769
 Total | 8.26911642 29 .285141945 Root MSE = .08124
-----------------------------------------------------------------------------
lnrgdp | Coef. Std. Err. t P>|t| [95% Conf. Interval]-------------
+----------------------------------------------------------------
gcfgdp .031256 .0069536 4.49 0.000 .0169348 .0455772
lntex .4327267 .0691198 6.26 0.000 .2903718 .5750815
lnexd -.049226 .0316424 -1.56 0.132 -.1143947 .0159428
inf .0027854 .0016111 1.73 0.096 -.0005327 .0061035
_cons 7.752337 .4453227 17.41 0.000 6.835178 8.669497
------------------------------------------------------------------------------

APPENDEX B
vif multicollinearity
Variable | VIF 1/VIF
-------------+----------------------
lntex | 14.43 0.069308
gcfgdp | 10.28 0.097295
lnexd | 6.40 0.156341
inf | 1.41 0.710415
-------------+----------------------
Mean VIF | 8.13
hettestBreusch-Pagan / Cook-Weisberg test for heteroskedasticity
Ho: Constant variance
Variables: fitted values of lnrgdp
chi2(1) = 0.10
Prom>chi2 = 0.7578
APPENDEX C
table 5.1-DATAS USED IN REGRESION
gcf
year lnrgdp %gdp lntex lnexd inf%
11.5826 8.85466 7.86518
1984 5 12.2 5 8 -0.3
11.6770 9.09268 8.50936
1985 6 13.4 2 3 16.4
11.8084 9.09661 8.25634
1986 3 12.8 2 8 6.5
9.07188 8.10379
1987 11.8079 13.7 3 7 -9.6
9.19105 8.51519
1988 11.8113 16.1 6 1 2.3
11.8511 9.07027 8.17244
1989 7 14.3 3 7 9.6
11.8142 9.20099 8.40737
1990 5 14.8 7 8 5.2
11.7766 9.28405 8.45254
1991 5 15.2 5 8 20
11.8899 9.31154 8.50875
1992 8 16 2 8 21.9
11.9068 9.51672 9.10908
1993 3 15.9 2 3 7.7
11.9591 9.80851 9.27369
1994 9 16.4 7 1 3.3
12.0601 9.81098 9.35383
1995 2 16.9 8 4 13.4
12.1057 10.0710
1996 6 17 3 11.5005 0.9
12.0912 10.0340 9.47070
1997 3 17.2 3 3 -6.4
12.1494 9.97343
1998 5 16.9 3 9.20583 3.9
12.1940 9.21522
1999 6 15.9 10.0908 8 4.3
12.2746 10.1676 9.39341
2000 4 17.8 6 2 5.4
12.2895 9.79979
2001 4 23.6 10.2338 2 -0.3
12.2676 10.2669 11.2470
2002 3 22.8 8 6 -10.6
12.3965 10.5079 10.2299
2003 4 21.3 9 8 10.9
2004 12.5075 21 10.6322 10.2443 7.3
 2 9 4
12.6097 10.6467 10.3290
2005 5 22.4 8 8 6.1
10.3095
2006 12.7179 25.8 10.6703 5 10.6
10.6642 10.5126
2007 12.82 24.6 9 6 15.8
12.9032 10.6655 10.8428
2008 1 29.2 5 3 25.3
13.0232 11.0452 11.4982
2009 6 28.5 2 7 36.4
13.1335 11.3615 11.2030
2010 9 31.7 8 8 2.8
13.2172 11.4650 11.3840
2011 5 32.11 2 5 18.1
13.3158 11.5377 11.4024
2012 5 37.1 4 7 34.1
11.7169 11.4101
2013 13.4295 34.08 4 6 13.5
SOURCE; MoFED, NBE,CSA) & WB (2017 )
ALL VARIABLES ARE IN MILLION TERM EXEPT INF